(The opinions expressed here are those of the author, a

columnist for Reuters.)

By Jamie McGeever

ORLANDO, Florida, June 9 (Reuters) - All three major

U.S. asset classes - stocks, bonds and the currency - have had a

turbulent 2025 thus far, but only one has failed to weather the

storm: the dollar. Hedging may be a major reason why.

Wall Street's three main indices and the ICE BofA U.S.

Treasury index are all slightly higher for the year to date,

despite the post-'Liberation Day' volatility, while the dollar

has steadily ground lower, losing around 10% of its value

against a basket of major currencies and breaking long-standing

correlations along the way.

The dollar was perhaps primed for a fall. It's easy to

forget, but only a few months ago the 'U.S. exceptionalism'

narrative was alive and well, and the dollar scaling heights

rarely seen in the past two decades.

But that narrative has evaporated, as U.S. President Donald

Trump's controversial economic policies and isolationist posture

on the global stage have made investors reconsider their

exposure to U.S. assets.

But why is the dollar feeling the burn more than stocks or

bonds?

PENSION FUND-AMENTALS

Non-U.S. investors often protect themselves against sharp

currency fluctuations via the forward, futures or options

markets. The difference now is that the risk premium being built

into U.S. assets is pushing them - especially equity holders -

to hedge their dollar exposure more than they have in the past.

Foreign investors have long hedged their bond exposure, with

dollar hedge ratios traditionally around 70% to 100%, according

to Morgan Stanley, as currency moves can easily wipe out modest

bond returns.

But non-U.S. equity investors have been much more loath to

pay for protection, with dollar hedge ratios averaging between

10% and 30%. This is partly because the dollar was traditionally

seen as a 'natural' hedge against stock market exposure, as it

would typically rise in 'risk off' periods when stocks fell. The

dollar would also normally appreciate when the U.S. economy and

markets were thriving - the so-called 'Dollar Smile' - giving an

additional boost to U.S. equity returns in good times.

A good barometer of global 'real money' investors' view on

the dollar is how willing foreign pension and insurance funds

are to hedge their dollar-denominated assets. Recent data on

Danish funds' currency hedging is revealing.

Danish funds' U.S. asset hedge ratio surged to around 75%

from around 65% between February and April. According to

Deutsche Bank analysts, that 10 percentage point rise is the

largest two-month increase in over a decade.

Anecdotal evidence suggests similar shifts are taking place

across Scandinavia, the euro zone and Canada, regions where

dollar exposure is also high.

The $266 billion Ontario Teachers' Pension Plan reported a

$6.9 billion foreign currency gain last year, mainly due to the

stronger dollar. Unless the fund has increased its hedging ratio

this year, it will be sitting on huge foreign currency losses.

"Investors had embraced U.S. exceptionalism and were

overweight U.S. assets. But now, investors are increasing their

hedging," says Sophia Drossos, economist and strategist at the

hedge fund Point72.

And there is a lot of dollar exposure to hedge. At the end

of March foreign investors held $33 trillion of U.S. securities,

with $18.4 trillion in equities and $14.6 trillion in debt

instruments.

RIDING OUT THE STORM

The dollar's malaise has upended its traditional

relationships with stocks and bonds. Its generally negative

correlation with stocks has reversed, as has the usually

positive correlation with bonds. The divergence with Treasuries

has gained more attention, with the dollar diving as yields have

risen. But as Deutsche Bank's George Saravelos notes, the

correlation breakdown with stocks is "very unusual".

When Wall Street has fallen this year the dollar has fallen

too, but at a much faster pace. And when Wall Street has risen

the dollar has also bounced, but only slightly. This has led to

the strongest positive correlation between the dollar and S&P

500 in years, though that's a bit deceptive, as the dollar is

sharply down on the year while stocks are mildly stronger.

Of course, what we could be seeing is simply a rebalancing.

Saravelos estimates that global fixed income and equity

managers' dollar exposure was at near record-high levels in the

run-up to the recent trade war. This was a "cyclical" phenomenon

over the last couple of years rather than a deep-rooted

structural one based on fundamentals, meaning it could be

reversed relatively quickly.

But, regardless, the dollar's hedging headwind seems likely

to persist.

"Given the size of foreign holdings of both stocks and

bonds, even a modest uptick in hedge ratios could prove a

considerable FX flow," Morgan Stanley's FX strategy team wrote

last month. "As long as uncertainty and volatility persist, we

think that hedge ratios are likely to rise as investors ride out

the storm."

(The opinions expressed here are those of the author,

a columnist for Reuters)

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